Wall Street's Back – And Has Detroit by The Throat

While financial institutions drastically reduce lending again to private lenders and businesses, they’re also tightening the vice on cash-strapped public agencies from California to New Jersey.

This aspect of the financial meltdown has gotten less attention than the bonuses and the bailouts: how AIG and other Wall Street giants sold cities, towns, school boards and other public agencies high-risk investments and complex financing schemes during the boom. Now that the economy, the government agencies’ credit ratings and all those risky investments have gone bust, Wall Street is hounding cash-strapped governments from California to New Jersey for its money.

The result? Fewer schools and teachers, diminished public transportation and higher utility bills  – and more money for financial fat cats.

Because, under the terms of the contracts the agencies signed with Wall Street, the financial firms get paid first, before the public gets its services.

Some of the gory details were laid out recently in Business Week.

This story hits home with me, in part, because one of the places that has taken the worst punch from these bad investments is my hometown, Detroit, where my father spent his career teaching in the once-excellent public school system. We went for walks in beautiful Palmer Park and visited the world-class Detroit Institute of Arts, home to epic murals by Diego Rivera, and walked the cobblestone streets of old Detroit at the Detroit Historical Museum.

As the city’s fortunes declined with the auto industry, services were cut back, while Detroit, like many other places, pinned its economic future on gambling, in the form of revenues from three gleaming new casinos.

Meanwhile, Wall Street sold Detroit on complex money-saving schemes. Several years ago, Detroit struck a deal with UBS to save $2 million a year in interest on $800 million in bonds. But the fine print carried a “breakup” clause – if the city’s credit rating dropped, UBS could tear up the contract and demand a $400 million fee.

So now Detroit must use its casino revenue to cover a $4.2 million monthly payment to its banking creditors before the city can spend a dime on its citizens.

Detroit is far from alone in suffering a hangover from high-flying schemes hatched in the boom.

In New Jersey, the state’s transportation authority must pay Goldman-Sachs $1 million a month until at least December 2011 stemming from derivatives deals, even though the state retired the debt last year.

How did these cities and public agencies wind up investing in complex derivatives? The financial firms insist that the agencies knew the risks they were getting into.

But there have been widespread allegations of shady dealings, including kickbacks, rigged bids and inflated profits.

Last month, J.P. Morgan Chase agreed to pay $722 million to settle SEC charges that the firm made unlawful payments to help them win business involving municipal bonds and credit default swaps that led Jefferson County, Alabama to the brink of bankruptcy. A Justice Department investigation is continuing.

Also last month, A Sacramento utility filed suit against UBS, Bank of America and J.P. Morgan Chase charging that the banks rigged bids for derivatives and manipulated their terms. The month before, a federal grand jury indicted a Beverly Hills financial firm for taking kickbacks to steer work to favored investment firms that made excessive profits on investments sold to local governments around the country.

Earlier this year, the former chief of the self-regulating board for the $2.69 trillion municipal bond market acknowledged that his agency had failed to protect public agencies from more than $1 billion in losses from complex derivatives.

Derivatives aren’t the only way the financial titans have managed to wreak havoc on public agencies. In Chicago, the transit authority could owe investors $30 million in a deal in which the agency sold its equipment to investors and then leased it back. Under such leaseback deals, public agencies got much-needed cash while investors got a tax break. Wall Street’s finest, in this case, AIG, guaranteed the deals. But when AIG’s credit rating swooned amid the financial collapse, the investors demanded their money.

Several proposals have surfaced to get a handle on the municipal derivatives. Sen Robert Menendez, D. N.J. and Rep. John Lewis, D-Georgia, have proposed a 100 percent tax on termination fees associated with the derivative deals. Another proposal would limit the use of derivatives by agencies with less than $50 million in assets. Certainly these are a step in the right direction.

But the whole idea that UBS, Goldman Sachs and other firms which benefited from the various federal bailouts are putting the squeeze on public agencies reinforces the notion that Wall Street is filled with greedy predators that are clueless about the world the rest of us live in.